Enterprise, rather than aid, will boost the development of poorer countries

The Adam Smith Institute featured on Bono's website when he discovered that the ASI had advocated canceling poor countries' debts before churches and charities promoted the idea. Now Bono features on our site for his speech at Georgetown.  He said: "In dealing with poverty here and around the world, welfare and foreign aid are a Band-Aid. Free enterprise is a cure."

This is correct. Simply giving developing countries money often does not benefit them in the long term.  Even in the short term the aid often fails to reach the people who need it; some of it might diverted to a corrupt government.  And sometimes it might be a used to prop up dictatorial regimes.

Free enterprise is the cure because it can enable poor countries to generate wealth instead of depending on tiny transfers of it from richer countries.  Developing nations become wealthy by enterprise and trade, not by aid, and inward investment is a potent way of assisting this with a range of spillover benefits.  It boosts the business environment by assisting capital investment; around the world it accounts for about 15% of domestic capital formation.

The OECD points to its role in triggering technological advance. Technology is transferred from the developed country in four ways  - migration of skilled labour; the internationalization of research and development; horizontal linkages with competing companies in the same industry and vertical linkages with suppliers or customers in the developed country.  Inward investment also leads to human capital growth (or formation) and contributes to international trade integration.  The OECD concluded that inward investment benefits income and factor productivity growth more than domestic investment.

Critics point to repatriation of profits and low taxes paid by multinational investors, but they miss the point.  It is the profits and the low taxes that attract them to developing countries, and their economic activity creates jobs and infrastructure there and efficiently channels the countries' natural resources onto international markets.

Developing countries can play their part.  They can privatize the nationalized corporations often corruptly run by political cronies.  They can set up special economic zones as Deng Xiaoping did so successfully in China.  They can boost education as Singapore did early in its development.  They can create a tax-friendly environment to encourage more investment, and they can have low local income tax rates to increase domestic consumption to help fuel their growth.

The developed countries also have their role.  In addition to investment they can set examples of responsible corporate policies that respect property rights, treat their workers correctly, and keep clear of corrupt officialdom.  Most of all, they can open their markets to the goods produced in poorer countries and enable them to create wealth by trade, just as they did themselves when their own economies advanced.

Coming around to the Austrian view of investment and recessions

I don't think it's any surprise to anyone that Madsen and Eamonn, here at the ASI, are rather more Austrian in their view of the world than I am. This is partly just because they are but also because I'm not really sure that I believe in any school of macroeconomics at all. I can see that there are useful things pointed out by all of the different schools: quite happy to accept that the New Keynesians have a point about sticky prices and menu costs, the Marxists aren't entirely wrong to think that class can sometimes matter (which Englishman could reject that basic point?) and so on and on. But I'm also extremely doubtful that any of the various schools manages to capture the full complexity of the economy in the way that, say, the microeconomics of prices and incentives captures activity at that level.

However, this story certainly supports one prime contention of the Austrian story:

Spain's €1bn white elephant airport could be yours for just €100m The first private international airport in Spain that turned into one of the country's biggest white elephants is being sold off for just €100m.

A vast airport built where very few live, fewer go and apparently almost none wish to fly to. This is very much he Austrian story about recessions: the boom times allow monstrosties of this type to be financed and built. A misallocation of capital in fact. And once the system gets sufficiently clogged with such misallocations then recession is going to happen. Further, we'll not return to growth until these misallocations are liquidated and we're back to allocating our capital sensibly, not on these white elephants.

What turns people off this Austrian view is that it almost seems to glory in the bankruptcies which are a necessary part of cleaning up the messes of the previous misallocations. Which isn't quite what is being said: rather that this is a sad necessity which we've got to go through so we might as well recognise that. And as I say, this particular case shows that there's at least one solid truth in that Austrian view.

Demand Matters

Markets are about supply and demand. Scarcely a more banal thing could be said in economics, and yet some of the time it seems like free-market economists look only at supply. Glance over policy recommendations from a free-marketeer and you'll often see only tools for freeing up supply—labour market deregulation, planning reform, a bonfire of the quangos, an end to unbalancing subsidies or tax breaks, liberalisation of trade barriers. These are all fantastic things, which we definitely need. And even through the visor of the AS/AD model, even in a slump, these can make things better both by cutting prices and by raising wealth. But either deliberately or unconsciously, these economists are completely avoiding the demand side.

Is this because there are no doctrinaire libertarian things that can be done on the demand side? I've certainly heard many policies like quantitative easing called "socialism" by fellow travellers, but I'd like to think that my libertarian-leaning friends were more thoughtful than instinctively dismissing ideas they see as ideologically impure out of hand.

And further than that, there are things we can do to make the demand side more libertarian, at least if we don't make the perfect the enemy of the good. School voucher systems are not decried for their "socialism" by libertarians despite the fact that under these systems schools are still paid for and run by the state. Monetary policies that are more free market (and more sensible) than our current one should be looked upon in the same way. It's not the case that anything short of abolishing the central bank is "socialism"—unless we want to completely devalue the word. And even if an intermediate policy were a form of "socialism" or "central planning", the realistic alternative is not a free market in money, but an abysmal central plan!

What are these intermediate policies that free-marketeers seem to be ignoring? Firstly there is nominal income targeting, which relies on markets both to stabilise demand and to allocate that demand among competing industries according to consumer preferences; and secondly counter-cyclical taxes, which rise automatically in good times and fall in bad times. Those are both thoroughly libertarian and entirely focused on demand.

In fact, the two most important libertarian economists of the 20th century—Friedrich A. Hayek and Milton Friedman—both endorsed demand-side policy, in the right circumstances. Friedman blamed the US Great Depression on the Federal Reserve, allowing a massive collapse in the money supply and aggregate demand. Hayek said that after the inevitable collapse of a misallocated capital structure there could also be "secondary deflations", where aggregate demand collapses and there is a costly adjustment period. Both would support monetary policy to deal with this issue—stabilising demand, so as to avoid painful adjustments from big inflationary or deflationary shocks. If money is non-neutral in the boom, why would it be neutral in the downturn?

One response libertarians might make is that Say's Law shows there is nothing we can do about demand. But Say's Law clearly doesn't hold in the short-run, and Austrian economists who rightly critique the assumptions economists often make about equilibria should be absolutely clear of this. In the short-run, a dip in aggregate demand—absent any response from the government, central bank, or hypothetical free banks working together—necessitates a period of deflation. But we know that (at least nominal) wages are sticky-downwards, meaning that calling for an adjustment to the new equilibrium means calling for years of the grave evil of unemployment foisted on millions. Say's Law reasserts itself in the medium- to long-run, and by then the misery and destruction of potential wealth has all already happened.

What libertarians are missing is that the relentless focus on supply is leaving them almost completely out of the conversation, and thus leading to worse policy than necessary. If free marketeers were talking about the best things to do on the demand side, as well as on the supply side, then there would be less of the all-eggs-in-one-basket big project spending stimulus, and more diverse market-oriented ways of countering the demand shortfall.

Kick the 'wise men' out of the Bank of England

In today's City AM, newly-minted ASI fellow Lars Christensen (aka The Market Monetarist) writes on the 'Carney rule'. The Carney announcement is a tiny step in the right direction, he says, but as long as the 'wise men' of the Monetary Policy Committee are running monetary policy, policy will be erratic and unpredictable, preventing adequate planning by firms and adding to market panic in economic downturns. Instead, we should have a strict rules-based system of nominal GDP targeting:

A much better rule would have been to commit to stabilising the level of nominal GDP (NGDP), a measure of aggregate demand, keeping market expectations of NGDP growth on a 4 or 5 per cent growth path. This should be combined with an open-ended commitment to expanding the money base to hit this target. This would avoid the nitty-gritty of the Carney Rule and be clearer and easier to communicate to markets.

Monetary policy based on the discretion of “wise men” leads to market uncertainty and panicky jolts as investors react to tiny changes in central bankers’ pronouncements. Replacing the MPC with rules-based policy would bring discipline and predictability to the Bank of England far beyond what was outlined yesterday.

I would prefer to have no Bank of England at all, with money emerging from the market as outlined by Hayek in 1976. Having said that, perfect is not the enemy of good — replacing the discretion of 'experts' with predictable, market-led rules would be a huge step in the right direction. If Carney's new rule fails, it may come on to the agenda sooner than we think.

Self-sufficiency appeals to some, but the world gains by going global

Calls ask us to "buy local," supporting domestic industry and cutting back on "food miles."  The reasons advanced include saving fuel used in transportation, and not "exploiting cheap labour" in developing countries.  Self-sufficiency is, however, an expensive delusion.

This morning few of us draw our own well water to wash in.  Nor did we grow our own cotton and weave it into shirts.  We did not grow even our own wheat and combine it with “oaty goodness” to produce Cheerios. This is because we stick to what we can do, which is none of these things.

Specialization preceded globalization and is a major source of the world's wealth.  It involves producers doing what they do well, and producing more goods more cheaply that people could manage themselves.  Globalization extends it on a larger scale and to more peoples.  It gives domestic firms access to increased demand across the world, and it enables them to obtain lower cost raw materials and thus become more competitive and create extra jobs.  Consumers benefit, too, from lower prices that leave them more money to spend on other things.

Globalization means that firms can invest in overseas production, gaining the benefits of local skills for worldwide markets.  The Nissan factory in Sunderland, for example, represents inward investment of over £3.5 billion.  Meanwhile UK firms invest in production in developing countries, creating jobs there that raise the local standard of living.

Some blame globalization for the collapse of domestic industries, whereas what it did was to expose industries that were not viable without subsidies and protective tariffs.  Uncompetitive industries have indeed closed, and been replaced by ones that can hold their own on a world stage and sustain jobs that did not exist before.

Other critics bemoan the 'over-standardization' of global products, with the majority using Microsoft PCs or Apple computers.  It is true that globalization makes many standardized products widely available, but with economies of scale that keep them falling in price, and with access to improved communication achieved by using standard systems.

Nowhere are globalization's benefits more widespread than with food.  Our supermarket shelves are stacked with choices because the world is able to sell us their produce.  Many developing countries depend on food exports to improve the living standards of their people. And world hunger?  In the UK we import 50% of our food, and we produce more and cheaper food with 3% working on the land than we did when it employed 90%.  As modern farming methods spread and use land more efficiently, the world is producing more food and feeding more people.  Globalization helps poorer countries most of all, and it provides a viable way to close the development gap.   Self-sufficiency does not.

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Could people please stop trying to plan losers for us all?

An oft expressed contention is that if only we allowed those wise people in Whitehall to plan more of our lives then the future would be made so very much better that we won't mind paying the costs of having those wise people in Whitehall. One problem, among many, with this idea is that it does require the people we're paying for to be wise. Not something that I'm really willing to bet on, that. The Very British Dude makes an excellent point here:

.....the biggest change to transport technology on the horizon, the driverless car. Instead, the Lib-Dems are wibbling about High-Speed Rail which will be almost completely obsolete by 2050 as everyone will be snoozing in their own autonomous vehicles. Such vehicles will run door-to-door on a vastly greater network of tracks (let's call them "roads" shall we?) than any train network will ever be able to compete with.

This is exactly right I think. The planning that we're being offered is that we should have more of a 19th century technology in the 21 st century. And it's entirely ignoring the coming impact of a 21 st century technology.

The arguments in favour of HST and other fast trains etc are capacity and speed. We want or desire a rise in the capacity of people to move around the country simultaneously. And we also want to increase the speed at which they do so because time spent travelling is "dead time". That latter isn't really true what with mobiles and notebooks: and it most certainly won't be true when we're all sitting in the back seats of our Wi Fi enabled cars. Such cars will also solve some to all of the capacity problems: the current road networks can carry a great deal more traffic if it isn't all being directed by that all too fallible few pounds of meat called the human brain.

I will admit to being a little unsure about how quickly computer controlled cars are going to be rolled out. But it wouldn't surprise me at all if they were actually commonplace before anyone even starts breaking ground on HST. Which would be an interesting example of spending £40 billion on a project that was outdated before it was even begun, wouldn't it?

Mark Carney bottles it with baby steps

Mark Carney had the leeway to make radical change here but he's bottled it with baby steps.

The 'Carney rule', promising low interest rates and the possibility of more quantitative easing (QE) until unemployment is low or inflation rises, is definitely an improvement on the current regime. It gives firms clearer guidance on the future stance of policy, removing some of the uncertainty in the world economy today. I expect it to deal with some of today's demand shortage, and more importantly tomorrow's expected demand shortage.

But unemployment and inflation come from both aggregate demand (which the bank can control) and aggregate supply (which it has essentially no control over). Since neither of these numbers distinguish between changes in supply or demand, the Bank is still fumbling in the dark with its guesses over whether a change in inflation comes from demand (which means it should react) or supply (which means it shouldn't). This means firms are still left guessing, and it means that uncertainty still reigns.

What we really need is a truly rule-based system that takes discretion away from nine 'wise men' and uses market forecasts to create real stability. That system is nominal income targeting.

The unnecessary burden imposed by the UK's "green" energy policy

Green was traditionally the colour of money, but with UK and EU energy policy, it is increasingly the colour of cost. The renewables obligation requires UK energy producers to obtain a proportion of their output from renewable sources that are more expensive to produce, and these costs are passed on to energy users.  The renewables obligation now costs consumers £2 billion per year, and Bloomberg New Energy Finance predicts it will increase household electricity bills by 54% by 2020.  Inevitably this raises costs for business, causing some UK firms to lose competitiveness and limiting economic growth. The obligation costs firms about £2 per megawatt hour, double what the government thought it would cost by 2020, with further rises expected.

The EU bears some of the blame because its Renewable Energy Directive requires that 15% of the UK’s final energy consumption is from renewable sources.  This hits the UK worse than other European countries; our government estimates that we will bear 25% of the total EU-wide cost of the directive.

In addition to this are the subsidies given to green energy paid for by taxpayers.  Estimates put the cost to each household in Britain at £600 a year by 2020 unless the Chancellor reduces them. Taxpayers also fund the installation of environmentally friendly boilers up to the level of £2,300.  Such policies have led npower to estimate that the average household energy bill will rise from £1,247 to £1,487 by 2020, with energyhelpline even suggesting that it may rise to £2,000.

The carbon price floor, introduced in April this year at £16 per tonne of CO2 used for power generation, will increase gradually every year to reach the Treasury's goal of £30 per tonne by the end of the decade, and £70 per tonne in 2030.  This puts up the price of electricity; and because it is higher than in the rest of Europe it will drive heavy energy users out of the UK to the advantage of countries with lighter regulations. This so-called "carbon leakage" will cause a loss of jobs and tax revenue to the UK.

Environmentalists argue that fossil fuels are running out, and that a "green energy" policy prepares us for that, while combating global warming. But shale reserves now identified in the US and the UK indicate that gas is available with over 100 years of reserves at estimated use, perhaps more as extraction technology develops, and is cleaner than both coal and oil.  We are also learning how to use fuel more efficiently.  The implication is that the green energy policy is both expensive and unnecessary.  It will constrain our economic growth without achieving results commensurate with its burdens.

Apparently government does all the innovation around here

We have a new contender for silly economic theory of the year here. Marianna Mazzucato's book on how it's really the State, government, that invents everything and that therefore we must, umm, well, I'm not sure actually. Either allow the state to carry on inventing everything or tax everyone more.

Second, government has also increasingly accepted that it funds the risks, while the private sector reaps the rewards. What is emerging, then, is not a truly symbiotic ecosystem of innovation, but a parasitic one, in which the most lossmaking elements are socialised, while the profitmaking ones are largely privatised.

I've already spluttered and sworn about that one elsewhere. When the state takes 50% of all of the entire economic output of the entire country, evertyhing produced in aggregate by every man woman and child in the nation, quite how we can describe any profit at all as being privatised I'm not sure. But there's a larger error at the heart of the argument:

Conventional economics offers abstract models; conventional wisdom insists the answer lies with private entrepreneurship. In this brilliant book, Mariana Mazzucato, a Sussex university professor of economics who specialises in science and technology, argues that the former is useless and the latter incomplete. Yes, innovation depends on bold entrepreneurship. But the entity that takes the boldest risks and achieves the biggest breakthroughs is not the private sector; it is the much-maligned state.

You can prove pretty much whatever you want in any field if you decide to start by ignoring everything everyone else has found out about that field. And the economist who has done the work in this field, about government and private contributions to invention and innovation, is William Baumol.

His finding being that the state, government, and private industry are equally capable of inventing things. Whizzy new machines, whizzy new ways of doing things. He notes that the Soviets managed to make a satellite and a rocket to get it into space and there's pretty much no economic system more state directed than that Soviet one. However, he then goes on to note that innovation is not the same as invention. Innovation is the process by which these whizzy new things disperse through the society (the take up of new technologies if you like) and also the rate at which people find interesting things to do with this whizzy new invention.

The importance of this being that the innovation side is done vastly better by a private sector, a market based one. Technological adoption is faster, more things are found to be done with the invention and so on.

A perhaps even more potent example is the information and communications revolution. The US National Science Foundation funded the algorithm that drove Google’s search engine. Early funding for Apple came from the US government’s Small Business Investment Company. Moreover, “All the technologies which make the iPhone ‘smart’ are also state-funded ... the internet, wireless networks, the global positioning system, microelectronics, touchscreen displays and the latest voice-activated SIRI personal assistant.” Apple put this together, brilliantly. But it was gathering the fruit of seven decades of state-supported innovation.

Baumol's point is that the private sector could have come up with these technologies, even though it was the State that did. But only the private, or market, sector could have come up with the iPhone. And it is worth noting that absolutely no government anywhere has managed to come up with anything remotely approaching a smartphone. Which is, as I'm sure you'll be fascinated to learn, the technology with the fastest adoption rate globally of any technology ever.

Or, as Baumol didn't quite say, the Soviets did manage to put a satellite up there but 50 years after that they'd still not managed to make a domestic washing machine that worked. And as Ha-Joon Chang rightly observes, the washing machine has done more to reduce the burden of labour, to free women from its shackles, than any other invention. And it did indeed need the private, market based system to do that.

GM foods will be vital in feeding the future world

Prince Charles and eco-warriors rail against them, but genetically modified crops are becoming the superheroes of agriculture, and they have special powers. Some are being developed to be pest-resistant, potentially saving the 50 percent of crops destroyed each year by pests.  This means less pesticides, less run-off and less river pollution; this limits soil erosion, pertinent in developing countries where over-farming poses a greater problem. GM crops have avoided 200,000 tonnes of insecticide and the multiple sprays of fungicide that potatoes need. One promising development is of crops that will host nitrogen-fixing bacteria instead of needing vast quantities of nitrate fertilizers.

Drought-resistant crops including maize (corn) have been developed, important in developing countries with unreliable rainfall.  Ones that can grow on marginal land enable more food to be grown without cutting back rainforest.  Others resist elements in acidic soil, and some have been developed to mop up toxic chemicals and return polluted land to fertility.

GM increases yields using fewer resources (and chemicals) and with less pollution. And yield gains have been larger in developing countries. For example in Mexico a herbicide tolerant soybean has given a 9% yield increase; in Romania a similar one has averaged yield increases of 31%.  In the Philippines an insect resistant corn has averaged yield increases of 24%; in Hawaii a virus resistant papaya has increased yields by an average of 40% and in India an insect resistant cotton has led to yield increases of more than 50%. This confounds critics who allege that GM has yet to produce benefits; they are happening now.

GM crops are being developed to combat dietary deficiencies, notably the 'golden rice' that adds the vitamin A lacking in ordinary rice.  Since 670,000 children die from vitamin A deficiency each year, the potential is huge.  Although critics castigate GM crops as 'frankenfoods' that are unsafe to eat, there is no evidence to support this.  They have been around for 13 years, with 80% of US foods containing them, and without ill effects.  Undercooked food is riskier than GM food because it poses a real hazard.

Scientists estimate that world food production will need to be doubled by 2050, which cannot be done with conventional farming methods because there is insufficient land. However, if GM crops can increase yield on existing land and save much of the 50% lost to pests, the problem will be solved, and solved using less pesticides and fertilizers.  Ironically, GM offers the chemical-free farming lauded by environmentalists.  But GM is high tech and scientific, and they want us all to revert to simpler ways…